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13 February 2013

IMF: 'A Banking Union for the Euro Area'


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This paper elaborates the case for, and the design of, a banking union for the euro area. It discusses the benefits and costs of a banking union, presents a steady state view of the banking union, elaborates difficult transition issues, and briefly discusses broader EU issues.


The paper assesses current plans and provides advice. It is accompanied by three background technical notes that analyse in depth the various elements of the banking union: a single supervisory framework; a single resolution and common safety net; and urgent issues related to repair of weak banks in Europe.

The case for a banking union for the euro area is both immediate and longer term. Moving  responsibility for potential financial support and bank supervision to a shared level can reduce  fragmentation of financial markets, stem deposit flight, and weaken the vicious loop of rising  sovereign and bank borrowing costs. In steady state, a single framework should bring a  uniformly high standard of confidence and oversight, reduce national distortions, and mitigate  the build-up of concentrated risk that compromises systemic stability. Time is of the essence.

Progress is required on all elements. A single supervisory mechanism (SSM) must ultimately  supervise all banks, with clarity on duties, powers and accountability, and adequate resources.  But without common resolution and safety nets and credible backstops, an SSM alone will do  little to weaken vicious sovereign-bank links; they are necessary also to limit conflicts of interest  between national authorities and the SSM. A single resolution authority, with clear ex ante  burden-sharing mechanisms, must have strong powers to close or restructure banks and be  required to intervene well ahead of insolvency. A common resolution/insurance fund, sized to  resolve some small to medium bank failures, with access to common backstops for systemic  situations, would add credibility and facilitate limited industry funding.

The challenge for policymakers is to stem the crisis while ensuring that actions dovetail  seamlessly into the future steady state. Hence, agreeing at the outset on the elements,  modalities, and resources for a banking union can help avoid the pitfalls of a piecemeal  approach and an outcome that is worse than at the start. The December 2012 European Council  agreement on an SSM centred at the European Central Bank (ECB) is an important step, but  raises challenges that should not be underestimated. Meanwhile, to delink weak sovereigns from  future residual banking sector risks, it will be important to undertake as soon as possible direct recapitalisation of frail domestically systemic banks by the European Stability Mechanism (ESM).

Failing, non-systemic banks should be wound down at least cost, and frail, domestically systemic  banks should be resuscitated by shareholders, creditors, the sovereign, and the ESM.  A banking union is necessary for the euro area, but accommodating the concerns of non-euro  area European Union (EU) countries will augur well for consistency with the EU single market.

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© International Monetary Fund


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